At Atlas Capital Advisors LLC, we utilize a multiple-factor investment decision framework. Using statistical filtering and ranking criteria based on these factors helps determine a specific asset allocation. Our process drives us to choose stronger companies over weaker ones, allowing for higher expected returns while working to lower risk.

In 1992-1993, Eugene Fama and Kenneth French published several academic papers that provided investing ideas that expanded on the classic Capital Asset Pricing Model (CAPM). They showed that over long periods of time, 90% of returns from diversified portfolios can be explained by 1) beta (the essential CAPM factor explaining excess portfolio returns over market returns), 2) valuation and 3) size.

We recognize that no model is infallible and believe that human behavior is impossible to quantify. However, the Fama-French findings are extremely useful variables to use for screening potential investment candidates to include in a diversified portfolio. Below are the factors we consider in our investment decision framework. Graphic representations of each factor analysis yield similar images.

Value Factors

Price-to-Cash Flow (P/CF) ratio: The P/CF ratio is the ratio of a company’s share market value to its operating cash flow per share. Operating cash flow (OCF), as the name implies, is the cash a company earns from its normal business operations. One standard definition: OCF = EBIT (Earnings Before Interest & Taxes) + Depreciation – Taxes. OCF is a good measure of the strength of a company. In theory, companies with a lower P/CF will tend to perform better than those with a higher P/CF. We prefer to invest in companies with consistent cash flow and solid cash flow margins.

Price-to-Book (P/B) ratio: This is the ratio of a company’s market value relative to its GAAP book value. Book value is found on a company’s balance sheet and represents the total value of a company’s assets minus the value of its debt and other liabilities. We focus on this metric when analyzing the value of a company. We prefer to invest in companies with low price to book ratios.

Price-to-Earnings (P/E) ratio: The P/E ratio is the ratio of a company’s share market value to its net income per share. The P/E ratio is a widely known concept but we prefer the inverse ratio, the E/P ratio or earnings yield, for comparative analysis to bonds, REITs, preferreds and various arbitrage strategies.

Company Size Factor

The size of a company is represented by its market capitalization (Number of shares outstanding * market price per share). Typically, small companies tend to be more risky and produce higher excess returns compared to large companies. This is not always the case, and deviations from this rule can dramatically occur for long periods. However, company size, when considered alongside other key factors, can help the investment decision process.

Momentum Factor

Stock momentum is the concept that a stock that has performed well recently will continue to perform well and that one that has performed poorly will also continue to perform poorly. Behaviorally, people tend to hold on to and buy stocks that have consistently appreciated (even when a company has a disappointing quarter). Similarly, a stock that continues to plummet tends to cause panic, resulting in more people emotionally selling as price falls in a downward spiral. While this signal does not always hold, it is still a valuable indicator, especially when used in conjunction with others. Its primary importance lies in factoring human behavior tendencies as part of an investment thesis.

For those seeking more information on Ken French’s work, visit the Amos Tuck – Dartmouth site